The Indian startups ecosystem is at the cusp of creating more unicorns than ever before.

| ET Bureau | Updated: May 17, 2018, 08.10PM IST

After a gap of almost three years, unicorn sightings are round the corner. The new set of startups at the cusp of billion dollar valuation, or unicorn status, include a spectrum of companies in ticketing, insurance aggregation, logistics, room booking and grocery space.

InMobi, Flipkart were among the first Indian unicorns and there are about 10 at present, including Paytm and Ola.

“From a signalling point of view being a unicorn is great,” says K Ganesh, copromoter GrowthStory, a venture building platform. Often, becoming a unicorn is as easy as convincing investors that you have a model that works!

“If a startup raises next round at a higher valuation and convinces investors that he will be the last man standing (in that vertical), you will be on track to become a unicorn,” says Ganesh. Though what matters more is internal rate of return (IRR) — a reflection of profitability of a venture.

Crossing the milestone is no guarantee that a startup will continue to scale. A once promising ecommerce company crashed from a multi-unicorn status to a sub-unicorn. Zomato, a restaurant search and discovery app, is valued from sub-unicorn to a unicorn, depending on which brokerage report you look at — Morgan Stanley pegs it between $700 million to $2.5 billion.

Kunal Khattar, managing partner, AdvantEdge Partners (an early stage fund), says, “In India, unicorn is a measure of amount raised and not value created. It’s just positioning.” He believes lots of unicorns or potential unicorns have raised $400-$700 million, but have not created a sustainable business model commensurate with that fund raise. “If you raise $0.5 billion and are valued at $1 billion, it doesn’t speak much in terms of value created.”

Venture capitalist Aileen Lee, founder of CowBoy Ventures, a US-based seed fund, coined the term ‘unicorn’ in 2013. She choose the mythical animal to represent the statistical rarity of such a successful venture, as around 70% startups die at very early stage.

Unicorn defines the first significant milestone in a startup’s journey, based on valuation that investors are willing to bet on. The valuation, in turn, is based on growth potential rather than real returns, as the ‘growth’ could come via discounts, frequently seen among startups.

Joelle Sostheim, analyst, PitchBook, says, “Some unicorns sacrifice profitability to gain a large market share early in their life, only to find their products are not as sticky as they expected.” New York-based PitchBook tracks venture capital/private equity (VC/PE) activity.

Unicorn or bubble Unicorn is valued at $1 billion. Decacorn is used for companies valued at $10 billion, while hectocorn for companies valued at $100 billion. The world’s largest unicorns include Uber and Airbnb. And there are quite a few dead unicorns as well. A Stanford research suggests that an average unicorn is overvalued by 48%. “Unicorn, decacorn ($10 billion valuation) are milestones. It’s good to be in that club but startups should be mindful of bubble building,” says Niren Shah, managing director, Norwest Venture Partners India.

Each funding round comes at a higher valuation — bringing the startup closer to $1-billion tag — unless it runs out of steam earlier itself. TaxiforSure and FoodPanda ran out of funds early on and were acquired by cab hailing app Ola. Others such as food startup TinyOwl were never in for the long haul.

Yet there are those companies which move ahead of the pack to become unicorn — with each round of funding leading to higher valuation. On May 9, Walmart picked up a 77% stake in Flipkart for $16 billion, valuing the ecommerce company at $20 billion.

Sostheim says, “Some unicorns sacrifice profitability to gain a large market share early in their life, only to find their products are not as sticky as they expected.”

While valuation is one part of the growth story, the second less visible part could make or break a unicorn. Deep discounts, cash backs, freebies make it easy to get customers and valuations, but add to negative unit economics and gross merchandise value (GMV) led growth without any profits to show. “Startup founders should ask: are we chasing vanity metrics?” says Shah, adding, “Intrinsic potential of a company is far more important than being a unicorn.”

For example, startups have been including not just sales in GMV but also refunds, cancellations and returns to create a mirage that helps feed in valuations’ without real money being added to the kitty. The hard part is to find an oasis – get to positive unit economics.

Discounts part of game... Yashish Dahiya, founder, PolicyBazaar, says, “Being unicorn means nothing at all. You are at a certain valuation. But a company can have value only if it has profits. A unicorn status in itself is ephemeral.” Founded in 2008, PolicyBazaar is another venture likely to get the unicorn tag soon. In its last round of funding, series E, in October 2017, PolicyBazaar raised about $75 million at a valuation of around half-abillion dollars.

While Dahiya dismisses unicorn as a fleeting moment he finds nothing wrong in discounts to create ‘value,’ saying, “Startups by nature are risky ventures, trying to change user habits — discounts is a way to do that. But in the process, burnout is high. Investors help create that value of $1 billion or more, but also know it’s not a fixed deposit. It’s an expectation of high return that drives companies to become unicorns or even larger.”

It’s all paper money and eventually comes down to building a strong, profitable business. “That’s how private capital plays a role in creating a market. Discounting model is based on expectation of the network going viral — then you have more users and try and create stickiness,” adds Vidya Shankar, executive director, Grant Thornton, an advisory and audit firm.

India is the last standing internet user market with plenty of headroom for growth—more than half the population is without internet access. That’s attracting investors to keep pumping money in hope to create large profitable businesses, never mind the short-term cash burn. Yet, says Shah of Norwest, “There has to be intrinsic value which helped you pull ahead of the pack – but reality is that unicorns are not built on that fundamental logic.”

... So is positive unit economics That’s why as companies turn unicorns they have to relook business models away from discounts led growth and to profitable growth. From negative unit economics to positive unit economics. “It’s not impossible, but business fundamentals need to be strong to do that,” says Dahiya.

As unicorns try to move away from discounts, they have to ensure users tag along. “Usually, investors won’t let a unicorn go bust unless, of course, there’s nothing to show. Unicorns have to be careful their model does not lead to a dead end or implosion,” adds Shankar and points out that positive unit economics can’t happen suddenly and depends on market strategy, market size, frequency of purchase and so on.

“Can you get the next 100 million people to use your services without dangling too many carrots? Innovation is the key to avoid imploding and that’s what will determine whether you can be a profitable unicorn,” says Shankar.

Not for everyone There could be multiple unicorns in a sector, but all may not survive. There’s room for maybe two or three companies in horizontal businesses and in verticals, maybe one or two. Others will have to look at a different model.

For instance, Amazon and Flipkart lead in ecommerce; Snapdeal and others have found managing scale much like moving up a greasy pole.

“An ecommerce startup burnt $2 billion in rebranding exercise after “deeply studying the market” and it’s today worth less than $100 million! That’s how unicorns might end up riding into oblivion,” says an investor who did not wish to be named.

At a peak in food tech, there were 50 startups. Most including Dazo, Yumist, TinyOwl shut shop. In the rush to get higher valuations on the back of deep discounts to lure users, they ran out of money with no choice but to close.

“BigBasket is almost there among unicorns. That’s because 40% sales come from own brands. But for other players, a goal to be unicorn may not be the right way. Better to look at, say a niche, like organic foods and build scale,” says Ganesh. Founded in 2011, BigBasket is at present valued at $850 million.

Khattar of AdvantEdge argues that instead of unicorn, Indian startups should have their own milestone—Indicorndefined at ?1,000 crore valuation.

In the US, per capita income is $60,000 and in India, $2,000. In the US, a $100-million fund raise can create a $1-billion company. In India, startups typically raise $400-700 million to create a valuation of $1 billion.

A lot of growth has come via discounts and cashbacks. But in the digital world, it’s easy for a user to move from startup A to B if the former has withdrawn sops and the latter continues to give. “Indicorn will be a better metric for the Indian startups,” Khattar adds.

Up till the end of 2015, India had eight to 10 unicorns — messaging app Hike and learning app Byju’s were the only two in the $1 billion club after that.

Now, Bookmyshow, PolicyBazaar, Freshworks are among startups at the cusp of being unicorns. With their next round of funding, they are likely to ride as unicorns. Even some like Quikr could bounce back into unicorn territory. Quikr was valued $1 billion in November 2017 by Kinnevik AB and in April 2018, the Swedish investor, a key shareholder in the online classifieds platform, downgraded it to $884 million.

“The new set of companies which are going to be unicorns have tried to avoid deep discounting led growth. There could be at least two or three unicorns in each business category (food, ecommerce, education, healthcare etc),” says Ganesh Raju, partner & leader, startups, PricewaterhouseCoopers, a consultancy.

Breed not easily found

Unicorns are rare in India, but their numbers are set to rise. In the US, there are 227 unicorns while China boasts of 164 $1-billion + ventures. Last year, there were 57 startups that crossed the unicorn milestone globally.

However, growth of new unicorns has slowed down globally. PitchBook’s Sostheim says, “As some unicorns have exhibited lacklustre performance or an unwillingness to exit, investors may be more selective in their investments, looking for strong financials and operations that will position a company to provide competitive returns.”

Besides, according to a PitchBook report, non-traditional investors such as hedge funds and mutual funds were heavily involved in unicorn deals. As they have pulled back, venture investors have become more disciplined, leading to slower growth of unicorns worldwide.

Some investors in India believe unicorn should be measured in terms of the impact they have on users. However, Shah of Norwest says that since India is seeking to integrate with rest of the world, we should avoid attempts towards localisation here. “Anyway, valuations — much like the unicorn — are mythical. Get real about the business.”

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